Richard Drury
By Jeff Shen | Rich Mathieson | Christopher DiPrimio
The Federal Reserve (“Fed”) remains committed to controlling inflation – raising concerns over potential damage to economic growth. Is the U.S. nearing a recession? BlackRock’s equity experts weigh indicators of recession risk as policymakers take action to bring down price pressures.
The Federal Reserve’s (“Fed’s”) aggressive policy stance has raised concerns over whether a US recession is on the horizon. After several years of steady growth and low inflation, policymakers now face a delicate tradeoff between bringing down inflation or sustaining economic growth amid heightened macro and market volatility. Given the Fed’s continued emphasis on combatting inflation, a few key questions arise: how much will they need to suppress demand to reduce price pressures and what is the likelihood of a U.S. recession?
In our view, answering these questions and understanding the current macroeconomic backdrop calls for a different toolkit and more dynamic investment approach than investors have needed over the past several decades. While traditional economic reports and government statistics provide a 30,000-foot view of the economy, understanding what’s driving these headline figures can hint at where the economy is headed.
As systematic investors, we use a process that transforms vast sets of unstructured data into useful investment information. This provides insights faster, at greater scale, and with more granularity than traditional reports as we navigate evolving inflation and recession risk.
Inflation continues to prompt Fed action
Throughout the economic reopening, the acceleration, or rate at which prices of goods are increasing, started to fall as consumer demand shifted back towards services. Recent stronger-than-expected inflationary data reveals an increase in the growth rate of goods inflation even with some signs of supply chain improvements and falling energy prices. Importantly, services inflation remains very strong and continues to accelerate.
The falling rate of service price increases shown in Figure 1 doesn’t mean that inflation is easing, but rather that it has remained elevated over time. In our view, sustained price pressures are largely driven by services which present unique challenges to an inflation-fighting Fed.
Figure 1: Acceleration across goods and services inflation 6m inflation acceleration shown as time series (z-score) (Source: BlackRock, Pricestats, as of September 2022. )
| Chart shows goods and services inflation acceleration, the second derivative of growth in inflation, expressed as time series (z-score). Figures above 0 indicate growth in the rate of price increases. |
Services inflation is particularly difficult for policymakers given that they have a limited ability to control what we view as a main driver of price pressures – labor supply. The labor shortage has remained a key production constraint since the pandemic caused many people to leave the workforce. To forecast changes in workforce participation, we monitor the volume of online job search activity across various websites in real-time. Our analysis suggests that labor supply remains roughly 10% below peak levels despite making a significant recovery from pandemic lows, as seen in Figure 2 below.
Figure 2: Job search volumes haven’t returned to peak levels Job search intensity distance from peak from 2018 – 2022 (%) (Source: BlackRock, Indeed.com Google Search, September 2022)
We also measure the strength of the labor market using data from online job postings which provides a 3-6 month forecast of realized employment cost data. Earlier this year, job postings showed a reacceleration in wages that’s now being reflected in average hourly earnings data. Figure 3 illustrates that despite an anticipated moderation in wage growth in the coming months, wage pressures are likely to stay elevated and labor market tightness may persist.
Figure 3: Wage pressures remain elevated Wage growth per income quartile (Source: BlackRock, Burning Glass Technologies, as of September 2022.)
| Q1 is the lowest income quartile, Q4 is the highest income quartile. |
Overall, inflationary pressures remain at a level that is unlikely to spur a change in course for policymakers. We expect the Fed to remain committed to aggressive rate hikes until we see normalization of the labor market and a sustained decrease in prices, which will be challenging given the remaining strength in spending data shown in the following section.
So what does this mean for recession risk?
Are we nearing a U.S. recession?
As recession concerns rise, we’re monitoring news articles and company releases for language related to job cuts and hiring freezes. As shown in Figure 4, we have yet to observe an uptick in mentions anywhere near highs seen during previous periods of declining growth such as the Great Financial Crisis and onset of the COVID-19 pandemic. Increasing mentions related to hiring slowdowns and job cuts are mainly concentrated in the technology sector and, to a lesser degree, the financial services industry.
Currently, we view this as a sector-specific trend rather than a reflection of the aggregate economy. We’re watching for signs of increasing mentions across a broader set of industries that would signal growing recession risk.
Figure 4: Job cut language isn’t broad-based Job contraction mentions across global markets (Source: BlackRock, DataStream, September 2022.)
We also measure the strength of the economy using real-time consumer transaction data across different income thresholds. Given the shift in spending from goods to services throughout the reopening, zooming in on service consumption allows us to see how inflation and recession fears are impacting activity where spending has remained the most robust.
While service spending for lower income cohorts is softening amid rising prices, activity remains relatively strong for middle- and high-income individuals (Figure 5). As we continue to monitor this, a broader retrenchment in service consumption across all income levels would indicate heightened risk of a near-term recession.
Figure 5: Continued divergence in service spending Discretionary service consumption by income cohort (Source: BlackRock, Earnest Research, September 2022.)
Navigating recession risk in 2022 and beyond
Our economic indicators remain mixed as inflationary pressures remain, but stable consumer activity and labor market strength point to a low probability of a near-term recession. The latter generally aligns with market expectations that the economy will remain healthy through the start of next year. However, in our view, persistent inflation will require the Fed to raise rates more than markets are currently pricing, ultimately causing this data to worsen over time. We expect investors will face more volatility and uncertainty in the coming months as the inflation vs. growth tradeoff continues to develop.
Braving the current regime of persistent inflation, lower growth, and heightened macro and market volatility will likely require a more nuanced and dynamic investment approach than what’s been needed in recent history. This starts with using alternative data for a real-time, more granular view into how the economy and markets are evolving ahead of traditional reports. Paired with expert human insight, this information edge allows us to remain nimble during a time where dynamism matters most-navigating market complexity and uncovering opportunities along the way.
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This post originally appeared on the iShares Market Insights.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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